Fortis Healthcare BUY Research Report by Motilal Oswal

Possibility of three-step value unlocking
According to media reports, IHH Healthcare Bhd, Asia’s largest private hospital operator, may announce acquisition of a controlling stake in Fortis Healthcare Ltd (FORH) and SRL Diagnostics. In this note, we have evaluated the possibility of a three-step value unlocking in FORH: 1) IHH/private equity buying a controlling stake in FORH, 2) fresh equity infusion, which will be used to buyback RHT and 3) acquisition of a controlling stake in SRL to help provide exit to the existing private equity players. We have tried and analyzed the impact of all the three events.

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Step-1: IHH/private equity buys controlling stake in FORH: According to media reports, IHH may buy a controlling stake in the company from the promoters, valuing FORH at INR140b. This would mean a fair value of INR270/ share (>35% upside from current levels).

Step-2: Fresh equity infusion in FORH to execute RHT buyback; TP will increase by ~20%: RHT is listed in Singapore with a market cap of ~INR35b in INR terms. Given that FORH will pay business trust (BT) cost of >INR4b to RHT in FY19E, at current market cap, RHT trades at 10.75x FY19E EV/EBITDA, significantly below hospital asset valuation of 20-22x forward EV/EBITDA. We believe that the acquisition of RHT will increase EV of FORH by ~INR60b. FORH owns ~30% stake in RHT, and thus, it will have to buy back the remaining stake (worth INR25b), for which it may look to raise fresh equity. Even after assuming dilution through fresh equity (share count increasing from 523m to 642m), our TP for FORH will increase from ~INR240 currently to INR290.

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Step-3: Acquisition of controlling stake in SRL can defer demerger: According to media reports, IHH may look to buy controlling stake in SRL. This will help provide partial/complete exit to the existing private equity. According to FORH, the demerger process will complete by July-17 end/ Aug-17 beginning. We believe that the SRL business demerger, coupled with stake acquisition in FHTL and asset sweating in existing hospitals, will help unlock significant value for FORH’s shareholders.

Hospital business EBITDAC to grow 3x over FY17-19E: Given that a large part of BT cost is fixed (except Chennai, no major greenfield addition expected in the near term), we expect normalized growth in BT cost to be in mid-singledigits (much lower than EBITDAC CAGR of ~20%). The impact of one-time reduction of INR1b in BT cost on annualized basis due to the FHTL transaction will also come in FY18. Lower base, coupled with strong growth in EBITDAC and relatively flattish BT cost, would result in a multifold increase in hospital EBITDA for FORH from INR0.5b in FY16 to INR5.4b in FY19E.

Top pick in healthcare delivery space: Although RHT buyback could act as a significant catalyst (will increase the TP by INR50), regardless of this event, we argue for a multiple re-rating in the stock on the back of a multifold increase in hospital business EBITDA, SRL demerger, asset light expansion strategy and FHTL transaction. We have rolled forward our valuation multiple to FY19E from 1HFY19E. We have valued the hospital business based on 20x FY19E EV/EBITDA and the diagnostics business based on 25x FY19E EV/EBITDA. FORH remains our top pick in the healthcare delivery space with a TP of INR240.

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